In the past few months there has been much speculation about the new amendment to Regulation Z, a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, that goes into effect April 1st of this year. As we draw closer to the date the mortgage industry is preparing for the change, but much is still unclear, especially for consumers. Though many have tried to interpret the Fed’s final rule, most that are publishing this information are not actually working within the mortgage industry and serve only to offer their interpretation of the rule, touting that it will be a great protection for consumers against abusive lending practices, and it will save them money. Unfortunately they cannot back up this promise, because they cannot offer the consumer any kind of example as to how the new rules will be applied in real life residential lending scenarios.
In order to dispel some of the rumors, and offer a more clear and accurate account of what the consumer can expect after April 1st, 2011, let’s start first with the main points of the final rule, as taken from the Federal Reserve’s press release on the matter http://www.federalreserve.gov/newsevents/press/bcreg/20100816d.htm:
· Prohibit payments to the loan originator that are based on the loan’s interest rate or other terms. Compensation that is based on a fixed percentage of the loan amount is permitted.
· Prohibit a mortgage broker or loan officer from receiving payments directly from a consumer while also receiving compensation from the creditor or another person.
· Prohibit a mortgage broker or loan officer from “steering” a consumer to a lender offering less favorable terms in order to increase the broker’s or loan officer’s compensation.
· Provide a safe harbor to facilitate compliance with the anti-steering rule. The safe harbor is met if: The consumer is presented with loan offers for each type of transaction in which the consumer expresses an interest (that is, a fixed rate loan, adjustable rate loan, or a reverse mortgage); and The loan options presented to the consumer include the following:
1. the lowest interest rate for which the consumer qualifies;
2. the lowest points and origination fees, and
3. the lowest rate for which the consumer qualifies for a loan with no risky features, such as a prepayment penalty, negative amortization, or a balloon payment in the first seven years.
The following is information gathered by my company here in Snohomish County, WA. We are a broker and a banker, it gives us a broader perspective on these changes, and greater access to different lender interpretations:
· Currently, as mentioned in a previous article, originators are paid one of two ways, or a combination of the two: via the lender (price based on interest rate) or via the borrower (fee charged up front- can be paid by seller on a purchase). The new rules will completely change this and the new compensation models will vary based on the type of institution the originator works for:
1. Banks and Bankers: Bankers are basically institutions that close mortgage loans, but then sell them on the secondary market. They do not service loans and further are not FDIC insured and do not offer checking and savings account etc . They are strictly in the market to close and sell mortgage loans, whereas banks do all of the above, depending on the bank. In the new originator compensation arena, these two types of institutions will implement the changes in much the same way. Each will come up with their own compensation plan for their originators. It will be a flat fee or basis points that each originator will make on every loan. From what I and my colleagues have seen, these plans range from a 50%-75% pay cut for the originator. Setting aside the fact that the originator may no longer be able to make enough money to feed his family, this should be better for the consumer because they will pay less for their loan. Right? Wrong. Not only will the originator be forced to charge what the bank dictates, and forced to offer the rate the bank dictates, the compensation the originator is missing on the loan does not go back to the consumer, it goes back to the bank.
2. Brokers: Mortgage Brokers are primarily small businesses that operate solely to facilitate residential mortgage loans. Brokers do not close loans in their own name and they also do not service loans. Instead they act as the liaison between the consumer and various banks. Brokers will pick multiple banks, or wholesale lenders to partner with in order to offer their clients the widest range of products and best interest rates. So far most wholesale lenders have said they will negotiate compensation plans with individual brokers based on the broker’s expectation, or current model of compensation. Brokers will not be paid on rate, but rather a flat percentage for each loan they broker with the wholesale lender. In this scenario the borrower would not be charged up front by the broker. Wholesale lenders will also offer a borrower paid option, so in essence brokers will choose, based on the client’s need, whether to charge the borrower up front or charge nothing and offer the wholesale lender’s rate of the day and receive lender compensation instead. Originators working for brokers will be making changes to how they offer loan options to a consumer, but they should be able to make a similar amount to their current compensation plan, if their Broker (the head of or owner of the mortgage brokerage) is passing the fair compensation on to their originators.
· The summary above covers how originators will receive separate compensation, either from a lender or a borrower, so the compensation plans put in place by lenders will generally cover the dual payments issue. However, there is one other important component to this facet of the rule. In a purchase situation, where the buyer is able to negotiate seller concession, or seller paid closing costs, as part of their purchase and sale contract, those concessions can go toward all closing costs and pre-paids except the originator compensation. So in that situation, if the borrower/buyer does not want to bring cash to close their purchase, they will have to choose the lender paid option the broker offers, or whatever no point option the bank can offer. This will allow less flexibility for the borrower and potentially the other parties to the purchase transaction.
· The steering rule is perhaps the least complicated of the changes. The mortgage industry plans to handle this portion of the rule by requiring all originators to offer consumers multiple options, in line with the safe harbor rules above. For example banks and lenders may require their originators to offer each borrower three options (unless the borrower qualifies for less than three). Two may be a 30 year fixed rate, one with and one without an up-front charge. The one without the up-front charge will likely offer a higher interest rate. The third will likely be either an ARM, or an alternative program such as Conventional VS FHA. Generally through discussion and the pre-qualification process the originator and borrower discuss all options available to the consumer and which might be most favorable. The biggest change under the new rule will be documenting that exchange, or putting it in writing via a form, or perhaps even on the Good Faith Estimate.
While there are several other smaller changes, and sub-rules within the rules, the above addresses the biggest changes both the industry and the consumer will see. It is unfortunate that when the Dodd-Frank Wall Street Reform and Consumer Protection Act was being written, mortgage industry professionals who actually serve consumers on a day to day basis were not consulted because those on the outside, even government do not truly understand the inner workings of the industry and the one on one relationship between borrowers and their originators. This rule, though well intentioned, does not necessarily benefit the consumer. It only creates more regulation for originators and lending institutions to wade through, and in some cases will provide an even less conspicuous compensation model for originators that the consumer will not likely understand.
Just like today, under the new rules consumers are best served by being educated about how the mortgage industry works, how brokers and bankers get paid and what is a fair interest rate. When all else fails, consumers should rely on their instincts and their friends and family. A referral to a trusted professional goes a long way, regardless of the industry. The outstanding mortgage professionals will continue to persevere and do what they do best, serve their clients with integrity and professionalism. Thankfully for consumers, no regulation is going to change that.